RBI Governor D Subbarao's viagra infusion of Rs 100,000 crores in liquidity through 3 cuts in CRR, followed by a cut in the repo rate, failed to raise the sensex. Nor did efforts by the Finance Minister and the Prime Minister to instil a measure of confidence through assurances that all was well with the Indian economy. The BSE sensex nonetheless fell a whopping 1274 points, to end the week at 8701. The only thing that went successfully up was Chandrayaan, launched by ISRO. Maybe attempts to hitch the sensex to the rocket headed for the moon may have helped it.
There is a total crisis of confidence and even at bargain basement prices, investors are too scared to invest in equities in fear of worst times ahead. Macro economic indicators and forecasts are gloomy. The Rupee has fallen to over 50 to the US $. Inflation, though falling, is still in double digits. GDP growth forecast for the current year is now at 7.5% (and further down to 6.6% for 2010), largely thanks to the services sector which accounts for some 63% of GDP. But in several service sectors, such as airlines, there is a sharp slowdown and a contraction; senior staff at Jet, e.g. are facing a pay cut of 30%. The Finance Minister has admitted inability to contain fisca deficit within the target set under FRBM; Goldman Sachs estimates it to increase to 8.4% of GDP.
Infrastructure, which needs an investment of $500 b., is an area where a Government push would help sustain the economic growth, were it not for the fact that it has been foolishly profligate in using tax resources generated during boom years. The Government has done nothing to develop a vibrant debt market, one that, by establishing a yield curve, would enable infrastructure projects to obtain long term funding, instead of relying, in its absence, on medium term funding which is rolled over. The credit crisis makes it very difficult to roll over whilst retaining viability of the project.
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Another risk, as pointed out by Ajit Gulabchand, of HCC, at an analyst meet recently, is that with the forthcoming elections in several states, followed by a general election, the Election Commissioner may decide to impose a freeze, pending election results, on infrastructure spending by states/centre. That would be lamentable. These are extraordinary times which call for extraordinary action by regulators. It is shameful that Parliament has worked only 34 days this year! Is there no accountability for those who make laws?
Having said all this, there are some positive signs too which long term investors should look for. With oil prices having fallen the balance of payment could actually turn positive; Prashant Jain of HDFC Mutual Fund expects it to be + $6b. for 2008-9. Once the dispute between the Ambani brothers is resolved (the Mumbai High Court decision is expected in November) and oil/gas flow from the KG basin starts, this would boost domestic availability by 40%. Gas supplied at a Government determined fair market value would remove the fertiliser subsidy of nearly Rs 100,000 crores, helping contain both budget and fiscal deficits. It would also reduce the dependence on bank funding by bankrupted oil marketing companies, allowing credit to flow to other sectors. With the stock market having fallen like a brick, P/E multiples are at a historically low level.
At current levels of equity prices dividend yields on several stocks are higher than deposit rates in banks. Since dividend income is tax free whilst interest income is not, it is basically fear of further erosion in stock prices that is making investors gravitate towards the safety of bank deposits. At some point confidence would return, though, given the gravity of the global meltdown, one does not know when. The market is unlikely to start running away; a bear market typically ends with a couple of months of sideways consolidation before it begins its ascent. There is thus no need to chase stock prices up in fear of missing the bus. Better to buy slowly at a price one is comfortable with, with conviction about the business one is investing in.
Corporate results for the quarter ended Sep 08 are a mixed bag with some companies showing increases in net profits (Bank of India up 79%, Tata Steel up 50%, Hind. Unilever up 34% and others) whilst some showed a dip (Maruti, Idea Cellular, Grasim and others). The quarter to Dec would also not show encouraging profit growth except for exporters who would benefit from the weakening rupee.
The global financial crisis is not over. The US is in recession (defined as two successive quarters of negative growth) and Mervin King, Governor or Bank of England, has warned that the UK is slipping into one. Russian companies have defaulted on $ 1 b. of debt, and have bonds of another $ 10b. due for redemption before the end of the year which would lead to further default. S& P has downgraded Russia's sovereign debt to negative, even though the country sits on $ 515b. of FX reserves. The collatarelised debt obligation (CDO) market is expected to result in losses of $ 1 trillion, atop the $660 b. of subprime mortgage default.
So yes, if there are further bank failures, investor confidence would take longer to return and the recovery in stock markets longer to happen. The likelihood of an early call for general elections (rumoured to be likely in February) would further depress sentiment and markets, but should that happen it would be a screaming buying opportunity. As Warren Buffet has pointed out, the market bottoms out earlier than the economy as has happened after each major crash in history. In the short term, markets will be driven by emotion; over the longer term by economic logic.